"Bad news is good” is a hard habit for investors to kick (Part 5 of 5)
So, rather than continue to hope for an unlikely sea change in Fed policy, investors would do better to focus on relative valuation, which has become a key differentiator of performance lately. Despite lingering economic headwinds, market segments with relatively cheap valuations have been attracting buyers, a trend I expect to continue.
Market Realist – Investor behavior has been pointing to a search for value for some time now. According to Russ, money continued to flow into emerging markets (EEM) and U.S. large caps (SPY) (IVV) in the last week. High-yield bonds (or HYG), which are relatively attractive in terms of valuations, also saw inflows in the past week.
Assets with high valuations are seeing outflows—for example, U.S. small caps. The Russell 2000 (IWM) Index for small cap stocks was highly valued at a price earnings multiple of 49x. The S&P 500 (SPY) (IVV) had price earnings multiples of 17.2x in March, 2014. According to research from Lipper, U.S. small cap exchange-traded funds (or ETFs) saw outflows of $1.2 billion in the last week. The total outflows from small cap funds since March amount to $10 billion.
Market Realist – The graph above shows the price performance of U.S. small caps against large caps. U.S. small caps started falling in March. They rebounded in June and started falling again thereafter.
According to Russ, Japanese (EWJ) stocks valuations currently stand at 1.4x their book value. This is ~50% cheaper than U.S. markets. Following the trends in a search for value, Japanese stocks rallied 3.5% last week. This was despite the news of a sharp 6.8% fall in Japan’s second quarter gross domestic product (or GDP).
Read our series on A key trend: Why relative value is trumping risk aversion to understand how investors have found a new interest in relative value.
Sources: Bloomberg, BlackRock Research
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